September 28, 2008

Any new student of accounting gets bewildered by the historical cost concept. The premise of this being that long term assets should be reported on the books at the value that they were bought at (apart from depreciation etc). The most commonly used example is that of land – land is usually reported on the books in the US system at the cost at which it was bought at. Land being such, usually appreciates and thus in the course of time, the value on the books ends up being being below the market value and firms are forced to report less assets than they have.

However, in recent years, firms have been allowed to report financial assets at market values instead of historical costs. For sometime this was considered a good idea, but in recent months has become the cause of much debate thanks to the credit crisis. The Economist last week had a great article on problems related to the same. An interesting point that the Economist brought out and which this writer was not aware of was

Today the treatment of a financial asset is determined by the intention of the company. If it is to be traded actively, its market value must be used. If it is only “available for sale” it is marked to market on the balance sheet, but losses are not recognised in the income statement. If it is to be “held to maturity”, or is a traditional loan, it can be carried at cost, subject to impairment. This is a dog’s breakfast. Different banks can hold the same asset at different values.

Noe this is indeed terrible. A big part of the problem recently has been one of the adverse selection problem. The only way around adverse selection problems is to reduce the level of assymetric information when it comes to dodgy products. Of course, this is easier said than done.

UPDATE: Justin Fox of Time has an interesting update on what’s happening on this front currently.

August 9, 2008

Business week has a nice article, which after everything is said and done, ends up advocating for some sort of Pigovian Taxation on Oil. Something a lot of analysis against taxation of oil misses is the simple fact that at the moment there is no economic cost associated with polluting the air (through the use of oil et al). Thus if everyone is sharing the common resource which is our atmosphere, some economic cost should be associated with its use/misuse, i.e. the Pigovian Tax on Carbon emission. That is unless you are one of those who believes the earth to behave like a perfect black body which radiates all the heat entering its atmosphere back into space almost instantly, green house gases be damned.

While I am no tree hugger, I am one of those who is happy everytime the price of oil rises – demand reduces, alternatives become affordable and our moronic politicians in Washington see a little more reason to look at that crazy little thing called public transport. Thanks to this article, I feel much less of a tree hugger and in esteemed company.

Also, Greg Mankiw explains here why that absurdity of chopping off the pinkie of the invisible hand aka Windfall Profits Tax is hardly Pigovian. I wonder how much part Jason Furman, a former student Prof Mankiw’s and one of the top people along with Prof Goolsbee on Obama’s economic team, played in this policy. But then, polictics can make even economists change their belief – give the people what they want!

A nice article by Martin Feldstein covering in very simple language why the dollar needs to continue to fall, and more importantly the considerations including the price of oil and domestic inflation which would affect how much the dollar needs to fall.

Also, I would think it would be interesting to see which way the dollar curve goes in the initial period after the new president is elected. On one hand, Obama is expected to work towards ending a resource sapping war in Iraq which is steadily adding to the deficit and so would be good news for the dollar. On the other hand, his populist promises and Big Brother spreading the money love all over the place wont bode well for inflation and the deficit. Instead, one would think a republican would be good. While Wall Street would prefer a republican, John McCain would love to continue his war and start a few more if he can help it, and cares trifle little for the economy at home. Now since the people who would affect the dollar are not on Wall Street but probably somewhere close to the Birds Nest stadium, it would depend on what they think of John McCain.

June 29, 2008

This article on capital inflows in China touches upon issues relevant to the conditions in India too.The issue is that the differential in interest rates between dollar and yuan results in inflows. To maintain the exchange rate, the PBOC sterilizes the yuan and this results in more money in the market and thus inflation. Recent appreciation in the Yuan has fueled more appreciation expectations resulting in exacerbation of inflows. The solution as per the article is to do a relatively larger appreciation of the Yuan which would suck out excess money from the market and also subside future appreciation expectations.

Coming to India, the current rate after the latest hikes is 8.5%. This is a substantial differential with respect to the dollar at 2%. On the top of it, with the WPI sitting unpretty at 11%, the need of the hour is to raise this even further to counter inflation problems. Now raising interest rates is a good thing (though the mismatch between repo and reverse repo rates is not). Thus while rates are being raised to counter inflation, this would increase inflows. With the current policy of sterilization, this would be counterproductive and work to raise inflation. In recent times, the RBI has increased the cash reserve ratio (CRR) a little to tackle the issue (something which China is doing too) but they can do this only so much. Thus unless the RBI changes its policy and starts letting the Rupee appreciate, it will be not very effective in countering inflation. In a normal scenario this would all be good if the RBI just listened. However, with investors starting to get a little bearish about emerging markets, the demand for the Rupee may go down. On the other hand, with recent corrections in the Indian equity markets, FIIs may not feel as bearish after all.

The Economist has a very well written Special Report on the future of energy. My only gripe – they did what they themselves call a cop out on the issue with nuclear energy, the treatment/storage of spent fuel.

June 13, 2008

The NYT has an article on the role of speculation in the commodity markets. The article goes on to talk about various opinions on the same. It even mentions Mr Masters view that speculation is only on the buy side. However, it does not address the contradiction with the first principle of futures markets – that contracts expire and unlike stock and bond markets , unless you dump your holdings you end up with a barrel of oil or a sack of grain or whatever at the agreed to delivery point. And if speculators are indeed forced to dump their holdings pre-delivery (I assume they do not want to hold on to their sacks of grain), there is only so much and so long that speculation can drive up costs. Now, speculation if existing would result in hoarding of commodities. However, as Ajay Shah points out and as Martin Wolf’s graph below shows, global inventories in food grains went down not up.

That and there is this other problem with the speculation on speculation

Thus, a pension fund that wants to put no more than 2 percent of its assets in commodities will have to sell some of its stake when its value rises above that percentage limit.

So, as in other markets, these investors “are stabilizing forces because when the asset goes up in value, they sell some to put their portfolios back into balance,” he said.

As for Mr Masters assertion, when asked about it he said that hedge funds and such were indeed starting to buy commodities for real (and I guess hoard them). So far, we’ve not seen much evidence of this but if he is indeed correct, then it would be a lot easier a problem to fix than if he is not.